A/HRC/31/60 Interrelationships between private debt, sovereign debt and financial crises 29. A boom in private debt is usually considered a more accurate predictor of financial instability than the level or development of sovereign debt. 38 However, sovereign debt may be, depending on the circumstances, a major factor for triggering or worsening financial crisis. For example, excessive sovereign debt in some countries has been a prominent contributor to the recent global financial crisis. Public and private debts are linked in many ways, often reinforcing the other’s negative effects, which may be described as a diabolical loop between both.39 Even when financial crises are not necessarily driven by public debt, such debt has an impact on the aftermath of crises, leading to more prolonged periods of economic depression.40 30. The consequences of a financial crisis on public finances are immense. Nationalization of private debts along with bailout and recapitalizing costs for the banking system have contributed to an explosion of sovereign debt. Even more important factors to the aggregation of sovereign debt are generally the fall in production, the consecutive contraction in the tax base and countercyclical policies set to fight the downturn resulting in higher government spending. If the country instead uses consolidation policies to reduce its debt, this often turns out counterproductive because of a negative impact of reduced government spending on economic growth and employment, as the International Monetary Fund (IMF) has recently acknowledged.41 31. There are several channels through which inequality affects private debt and financial crises. As a starting point, it is noteworthy that household debt and top income share — a standard indicator of inequality — are strongly correlated: in many countries, household debt and top income share have grown simultaneously and at similar pace over many years.42 Recent research has focused on credit demand and supply channels for explaining the nexus between private debt and inequality. 32. According to the credit-demand line of reasoning, private debt increases as households try to maintain certain absolute or relative levels of consumption, while facing growing inequality.43 In other words, people borrow more extensively to maintain their absolute or relative standard of living. Data collected for the United States of America confirm this interpretation: a study from 2006 revealed that, over the previous 25 years, income inequalities in the United States had increased without being followed by an increase in consumption inequalities.44 Some explain this as a result of a higher dispersion of transitory income, but it appears likely that massive permanent income shifts play a more 38 39 40 41 42 43 44 10 See M. Schularik and A.M. Taylor, “Credit booms gone bust: monetary policy, leverage cycles and financial crises, 1870-2008”, American Economic Review, vol. 102, No. 2 (2012), pp. 1029-1061. See M. Brunnermeier et al, “European Safe Bonds” (Euro-nomics group, 2011). See O. Jordà, M. Schularick and A.M. Taylor, “Sovereigns versus banks: credit, crises and consequences”, working paper No. 19506 (National Bureau of Economic Research, 2013). See IMF, World Economic Outlook 2012: Coping with High Debt and Sluggish Growth, World Economic and Financial Surveys (Washington, D.C., 2012); and N. Batini, L. Eyraud, L. Forni and A. Weber, “Fiscal multipliers: size, determinants and use in macroeconomic projections”, IMF technical notes and manuals No. 14) (Washington, D.C., 2014). See Bazillier and Hericourt, “The circular relationship between inequality, leverage and financial crisis” (footnote 28). See J.K. Galbraith, Inequality and Instability, A Study of the World Economy Just Before the Great Crisis (Oxford, 2012). See D. Krueger and F. Peri, “Does income inequality lead to consumption inequality? Evidence and theory”, Review of Economic Studies, vol. 73, No. 1 (2006), pp. 163-193.